Lecture 6
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Questions and Answers

What is an exchange rate?

  • The value of a currency in relation to other currency (correct)
  • The value of a currency in relation to the global economy
  • The value of a currency in relation to the domestic economy
  • The value of a currency in relation to inflation

    • Why does exchange rate regime matter?

  • Prices and wages are 'sticky' (correct)
  • Exchange rate regime has no impact on the domestic economy
  • Prices and wages move quickly
  • Nominal exchange rate has no real effects in the short run

    • Which is the primary objective of the European System of Central Banks (ESCB)?

  • To support general economic policies
  • To maintain price stability (correct)
  • To ensure employment
  • To promote sustainable growth

    • What is the Eurosystem's target inflation rate over the medium term?

    <p>2%</p> Signup and view all the answers

    What is the most important instrument used by the ECB to pursue price stability?

    <p>Interest rates</p> Signup and view all the answers

    What is the euro short-term rate (€STR) based on?

    <p>Daily confidential statistical information relating to money market transactions</p> Signup and view all the answers

    What is the interest rate parity condition?

    <p>Domestic interest rate = Foreign interest rate + expected exchange rate appreciation of domestic currency</p> Signup and view all the answers

    What are money market rates?

    <p>Interest rates used by banks for operations among themselves</p> Signup and view all the answers

    What is the harmonised index of consumer prices (HICP)?

    <p>A specific consumer price index developed by the EU</p> Signup and view all the answers

    What is inflation?

    <p>The increase in the general level of prices of goods and services in an economy</p> Signup and view all the answers

    What is the exchange rate stability criterion for euro adoption?

    <p>Being a member of the ERM for a minimum of two years without any tensions</p> Signup and view all the answers

    Which countries are expected to join the monetary union and introduce the euro?

    <p>All EU countries except Denmark</p> Signup and view all the answers

    What is the European Financial Stability Fund?

    <p>A transfer system in the EU to deal with the debt crisis</p> Signup and view all the answers

    What is the purpose of the ERM II?

    <p>To stabilize exchange rates between EU countries</p> Signup and view all the answers

    What was the highest average annual inflation rate in the EU?

    <p>3.7%</p> Signup and view all the answers

    What is the definition of an asymmetric shock, according to the text?

    <p>An event that has different economic effects on different parts of a given region.</p> Signup and view all the answers

    What are the three classic economic criteria for an optimal currency area, according to the text?

    <p>Labour mobility, product diversification, openness.</p> Signup and view all the answers

    What is the impact of a currency area becoming more diverse, according to the text?

    <p>It becomes more costly.</p> Signup and view all the answers

    Which of the following is a type of exchange rate regime where the central bank buys and sells its own currency without pursuing a particular exchange rate target?

    <p>Managed floating</p> Signup and view all the answers

    If the H currency depreciates against the F currency, what happens to the price of exported products by H for buyers in country F?

    <p>They become cheaper</p> Signup and view all the answers

    What happens to production costs when the domestic currency depreciates and some inputs needed to produce the good come from abroad?

    <p>They increase</p> Signup and view all the answers

    What is the relationship between interest rates and exchange rates?

    <p>Lower interest rates lead to higher exchange rates</p> Signup and view all the answers

    Which of the following is true about exchange rates?

    <p>If the rate €/$ decreases, the € is depreciating against the $.</p> Signup and view all the answers

    What is the impact of a domestic currency appreciation, according to the text?

    <p>There is a loss of competitiveness and, consequently, prices (or costs, such as wages) will fall to restore competitiveness.</p> Signup and view all the answers

    What is the interest rate parity condition?

    <p>When the returns on domestic and foreign assets are equalized</p> Signup and view all the answers

    What are the three rates set by the Governing Council of the ECB?

    <p>Interest rate on main refinancing operations, rate on deposit facility, and rate on marginal lending facility</p> Signup and view all the answers

    What is the Eurosystem's target inflation rate over the medium term?

    <p>Below, but close to, 2%</p> Signup and view all the answers

    What are some of the policy instruments used by the ECB since the financial crisis?

    <p>Offering central bank loans, purchasing financial assets, providing forward guidance</p> Signup and view all the answers

    Which of the following is true about inflation in the EU?

    <p>Inflation in the EU peaked in 2008 and subsequently decreased.</p> Signup and view all the answers

    What are the potential costs of a currency area becoming more diverse, according to the text?

    <p>Increased marginal costs due to the area becoming more costly.</p> Signup and view all the answers

    Which of the following countries is NOT currently a member of the Eurozone?

    <p>Sweden</p> Signup and view all the answers

    What is the exchange rate stability criterion for euro adoption?

    <p>Having a stable exchange rate for a minimum of two years</p> Signup and view all the answers

    What is the purpose of the European Financial Stability Fund (EFSF)?

    <p>To provide fiscal transfers to EU member countries in need during times of crisis</p> Signup and view all the answers

    What is the difference between a fixed exchange rate and a managed floating exchange rate?

    <p>In a fixed exchange rate, authorities declare an official parity vis-à-vis another currency or a basket of currencies, while in a managed floating exchange rate, central banks buy their own currency when they consider it too weak, and sell it when they see it as too strong, but they refrain from pursuing any particular exchange rate target.</p> Signup and view all the answers

    How does a depreciation of the domestic currency affect the cost of production for exported goods?

    <p>It increases the cost of production because some of the inputs needed to produce the good will come from abroad and will be more expensive when the domestic currency depreciates.</p> Signup and view all the answers

    What is interest rate parity?

    <p>The relationship between interest rates and exchange rates.</p> Signup and view all the answers

    What is the impact of a currency area becoming more diverse?

    <p>It may increase the likelihood of asymmetric shocks and make it more difficult to pursue a common monetary policy.</p> Signup and view all the answers

    What is the definition of a free floating exchange rate regime?

    <p>A regime where the exchange rate is allowed to fluctuate based on market forces without intervention from the central bank.</p> Signup and view all the answers

    What is the impact of a domestic currency appreciation on a country's competitiveness, according to the text?

    <p>There is a loss of competitiveness.</p> Signup and view all the answers

    What is the impact of asymmetric shocks on a currency area?

    <p>They can lead to different economic effects on different parts of a region</p> Signup and view all the answers

    What is the interest rate on the deposit facility offered by the ECB?

    <p>Lower than the main refinancing operations rate</p> Signup and view all the answers

    What is the euro short-term rate (€STR)?

    <p>The wholesale euro unsecured overnight borrowing costs of banks located in the euro area</p> Signup and view all the answers

    What is the impact of inflation on the purchasing power of consumers?

    <p>Inflation decreases the purchasing power of consumers</p> Signup and view all the answers

    What are money market rates?

    <p>Interest rates used by banks for operations among themselves</p> Signup and view all the answers

    What is the ERM and what is its relationship with the euro adoption?

    <p>The ERM is a European currency exchange mechanism that requires countries to maintain a stable exchange rate for at least two years to qualify for euro adoption.</p> Signup and view all the answers

    What is the exchange rate stability criterion for euro adoption?

    <p>The exchange rate stability criterion requires countries to maintain a stable exchange rate for at least two years without the presence of 'severe tensions' for the currency exchange rate.</p> Signup and view all the answers

    What is the difference between a fixed exchange rate and a managed floating exchange rate?

    <p>A fixed exchange rate is when authorities declare an official parity vis-à-vis another currency or a basket of currencies, with margins of fluctuations around the central parity, while a managed floating exchange rate is when central banks buy their own currency when they consider it too weak, and sell it when they see it as too strong.</p> Signup and view all the answers

    Study Notes

    Exchange Rate and Currency

    • An exchange rate is the price of one country's currency in terms of another country's currency.
    • The exchange rate regime matters because it affects the stability and volatility of the economy.

    European System of Central Banks (ESCB)

    • The primary objective of the ESCB is to maintain price stability.
    • The ESCB is composed of the European Central Bank (ECB) and the central banks of the EU member states.

    Eurosystem and Inflation

    • The Eurosystem's target inflation rate over the medium term is below, but close to 2%.
    • The ECB pursues price stability through monetary policy, using instruments such as the main refinancing rate, the marginal lending rate, and the deposit rate.

    Interest Rates and Exchange Rates

    • The euro short-term rate (€STR) is based on the wholesale euro unsecured overnight borrowing rate.
    • Interest rate parity is a condition where the difference in interest rates between two countries is equal to the expected change in the exchange rate between the two countries.

    Inflation and Consumer Prices

    • Inflation is a sustained increase in the general price level of goods and services in an economy over time.
    • The Harmonised Index of Consumer Prices (HICP) is a measure of inflation used by the ECB.

    Euro Adoption and Currency Areas

    • The exchange rate stability criterion for euro adoption is that the country's currency should have been a member of the ERM II for at least two years, with a stable exchange rate.
    • Countries expected to join the monetary union and introduce the euro are EU member states that have not yet adopted the euro.
    • The European Financial Stability Fund (EFSF) provides financial assistance to EU member states experiencing financial difficulties.

    Money Market and Interest Rates

    • Money market rates are the interest rates at which banks and other financial institutions lend and borrow money.
    • The three rates set by the Governing Council of the ECB are the main refinancing rate, the marginal lending rate, and the deposit rate.

    Currency Areas and Shocks

    • An asymmetric shock is a shock that affects one country or region more than another, making it difficult for a common monetary policy to respond.
    • The three classic economic criteria for an optimal currency area are labor mobility, fiscal transfers, and price flexibility.
    • A currency area becoming more diverse can lead to potential costs, such as increased difficulty in responding to asymmetric shocks.

    Exchange Rate Regimes

    • A fixed exchange rate regime is where the central bank pegs the exchange rate to a fixed value, while a managed floating exchange rate regime is where the central bank intervenes in the foreign exchange market to influence the exchange rate.
    • A free floating exchange rate regime is where the exchange rate is determined by market forces, without central bank intervention.

    Other Key Facts

    • The interest rate parity condition is a condition where the difference in interest rates between two countries is equal to the expected change in the exchange rate between the two countries.
    • A depreciation of the domestic currency can lead to an increase in production costs if some inputs are imported, and can make exports cheaper for foreign buyers.
    • A domestic currency appreciation can lead to a decrease in competitiveness, as exports become more expensive for foreign buyers.
    • The ECB has used unconventional policy instruments, such as quantitative easing and negative interest rates, since the financial crisis.

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    Test your knowledge of EU inflation rates and consumption patterns with this informative quiz. Explore the factors that influence the overall shopping basket in different countries and see how inflation rates have fluctuated over time. Perfect for anyone interested in economics or current events.

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